How Much Cash Flow Do I Need to Retire?
If you want to retire, you’re going need enough cash flow to cover all the expenses in your life. So in order to determine exactly how much cash flow you need you’ll need to do an extensive and in-depth analysis of your personal finances.
It’s your job to comb through your bank statements, credit card statements, cash transactions and all records of your spending to determine exactly how much money you spend in a month (or a year). Your monthly (or yearly) cash flow will need to equal or surpass that amount before you can safely retire.
Your Minimum Requirement is Net Zero Cash Flow
Cash flow is literally just the amount of cash flowing into your bank account minus the cash flowing out of your bank account. The absolute minimum you need to retire is net zero cash flow after removing the cash flow from your job.
That means when you quit your job, the cash flow from your investments needs to be able to consistently cover all your life’s expenses.
I’ll show what I mean with a quick example:
- Monthly cash from investments: +$3,250
- Monthly cash from job: +$4,500
- Total monthly expenses: -$3,850
- Total cash flow: +$3,900
As long as you continue working your job, your cash flow is positive $3,900 ($3,250 + $4,500 – $3,850). But the moment you quit your job your cash flow changes. You no longer have cash coming from your job.
- Monthly cash from investments: +$3,250
- Total monthly expenses: -$3,850
- Total cash flow: -$600
This second calculation is the one that needs to be net zero. You need your cash flow from your investments to be able to cover all your expenses.
This is an oversimplification, but it’s a great starting point. For example, your job may have some hidden benefits that you don’t immediately think of. Also, since you need your cash flow to continue cover your expenses for years to come you’ll need your cash flow to increase over time in order to meet the demands of inflation.
Now that we understand the basic cash flow requirement to retire, let’s get into every detail and come up with a specific cash flow number for you.
Step 1: Determine Your Current Total Monthly (or Yearly) Expenses
When calculating a cash flow number for retirement, you should start with your expenses. After all, your minimum cash flow number is just whatever your expenses are.
You need to go back through your bank statements and credit card statements and anywhere you have evidence of what you spend and start writing everything down.
Here’s a list of common monthly expenses:
- Auto loan payments
- Auto insurance
- Home insurance
- Renters insurance
- Health/Vision/Life/etc. insurance
- School loan
- Other loans
- Utilities (electric, water, sewer)
- Streaming services (Netflix, Hulu, Disney+)
- Subscriptions (magazines, websites, newspapers, software)
- Gym membership
- Entertainment (movies/rentals, getting drinks, comedy club, theatre/musicals, concerts, Xbox live)
- Miscellaneous (Car repairs, home repairs, other unexpected expenses)
And here are some examples of yearly expenses (just divide each one by 12 to get the monthly cost):
- Property taxes (don’t include these if they are included in your mortgage payment)
- Amazon Prime
- Holiday/birthday gifts
- Auto registration fees
- Insurance premiums (can be yearly or monthly)
- Tax preparation
It’s important to get an accurate picture of how much you spend (on average) in a month, so DO NOT IGNORE ANY EXPENSE. If you spent $4 dollars at your neighbor’s daughter’s lemonade stand last month, it should make it into your expenses.
At this point we don’t need a final number, just write down everything and make sure you are confident you have close to 100% of all the money you’ve spent in the past year.
Step 2: Determine Changes to Your Expenses After Retirement
Now you have a great start, but remember you’re planning to quit your job. A job which likely offers benefits beyond just a paycheck. When you retire these benefits are going to disappear just like the paycheck. This can change your monthly expenses.
I don’t much about employers outside the U.S. but employers may offer various insurance coverage and retirement benefits.
Think about how losing these benefits will affect your expenses and add those things to the list you have created.
For example, if you currently pay $100 per month for health insurance and your employer pays $300 per month for your health insurance, then your monthly health insurance expense will be going up when you retire.
If your employer pays for some other insurance that you intend to keep after retiring, then you need to add that expense to your list.
Step 3: Write Down Your Total Monthly Expenses Number
You should now have a comprehensive list of every expense in your life today, along with a list of additions or adjustments to that list based upon what happens when you retire.
It’s time to consolidate this list into a single number, your average monthly expenses.
For monthly expenses, just add them all together. For yearly expenses, divide the number by 12 and add it on. Once you’ve added up everything you have you minimum after-tax cash flow number.
Note: If you’re anything like me, you may want to add 10% or so to the number to account for any oversights. Multiply the number by 1.1 to give yourself a safety cushion in cash you missed any expenses.
When you have your final number, write it down and save it somewhere.
Step 4: Determine Your Current Before-tax Cash Flow From Investments
Now it’s time to make sure we fully understand how much cash flow our investments will be giving us in retirement. There are many types of investments, but they can all be characterized in two ways:
- Cash flow
- Capital Gains
Investments can have a cash flow aspect and a capital gains aspect. Some investments will have both and some will only have one or the other.
Cash flow is what the investment pays out for as long as you own the investment. If you own a stock, then it may pay out dividends. This is cash flow. You never have to sell your stock and you still get those dividend payments.
Capital gains is what you get when you sell an investment. When you sell your stock, you have a capital gain equal to the amount you sold it for minus the amount you bought it for. If you bought it for $100 and sold it for $120, then you made $20 and that $20 is your capital gain.
I prefer to ignore capital gains when calculating cash flow for retirement, but if you have most of your money in stocks, then you may be depending on capital gains to contribute to your cash flow.
Step 5: Determine Your Current After-tax Cash Flow From Investments
Different types of income are taxed differently. Tax laws are not always straightforward so I will not attempt to walk you through this calculation.
I’ll say only that stock dividends have their own tax rules, short and long term capital gains each have their own tax rules and cash flow from other investments will also have their own tax rules.
In general, the tax rules for personal income (the taxes you get from working your job) are as bad as it can get. So if you treat all your income as personal income and apply the relevant taxes, you should never be caught off guard with your taxes.
Step 6: Write Down Your Final Retirement Cash Flow Number (Before and After Tax)
Now you should have your total expenses per month after retiring, and your current before-tax and after-tax monthly cash flow from investments.
At a minimum, you need your after-tax monthly cash flow from investments to equal your average total monthly expenses. Once your after tax cash flow from investments can completely cover your average total monthly expenses, you can retire.
I created the Investor’s Handbook to help walk investor’s step by step through the process of acquiring cash flowing assets to the point where they can quit their job.
The software will help you identify your total monthly expenses and organize your investments to reach your retirement cash flow goal.
Don’t Forget About Inflation!
Depending on what type of investments you have, inflation could play a major role in how well your investments continue to cash flow.
In the U.S. inflation rate averages about 3%, which means in 10 years you’ll need $135 in cash flow for every $100 in cash flow you need today.
What does this mean for retirement? It means that you need your cash flow to be increasing as time goes on. If your inflation rate is 3% (like in the U.S.) then your cash flow needs to increase by about 3% each year.
Stock Cash Flow and Inflation
Cash flow from a stock portfolio comes from dividends and possibly from the regular sale of some of those stocks. Since dividends are paid out as a percentage of the value of the stock, and because the value of stocks have historically outpaced inflation by a fair margin, your dividends payments should easily outpace inflation as long as you don’t sell your stocks.
But if you are planning to sell some of your stocks to produce additional cash flow, then you’ll need to be more cautious in order to maintain your lifestyle over time.
I’m not an expert in retiring from stock market investing, and there are many articles written on the topic of managing your stock portfolio after retirement.
Here’s what I do know. Historically, the S&P 500 has about a 10% total return on investment each year. Approximately 3% of that is from dividend payments and 7% is from the increase in stock value.
You’ll be using the 3% from dividends to pay for living expenses (instead of reinvesting), so you’re looking at only a 7% increase in value in order to sell from.
If you count 3% of that against inflation and that allows you to sell 4% of your stocks whilst keeping pace with inflation.
Caveat: This only works in a perfect world where every year sees identical ROI, so you shouldn’t just blindly sell 4% of your stocks each year.
Real Estate Cash Flow and Inflation
I don’t worry too much about real estate cash flow keeping pace with inflation because rent is one of those things that goes up over time along with inflation. As long as you don’t have loans against your property with crazy high interest rates, you should have no problem keeping up with inflation as long as you continue to raise your rental price over time.
Business Cash Flow and Inflation
Business is more volatile than real estate, but again you should be able to reasonably charge more for your products and services over time. So as long as your business stays healthy you should be able to keep up with inflation.
In order to retire you need enough cash flow from outside your job to cover all your life’s expenses. That means you need to have a very good understanding of all your expenses before you can determine your necessary cash flow number.
I recommend looking back at least a year and coming to an understanding of all your expenses. If your investments can bring in enough cash flow to pay for those expenses, then you can retire.